Datalink Corp.: Corporate storage systems that deserve some respect

Richard Brandt | May 21, 2008 6:20am EDT | 1 Comment

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The amount of data that corporations must store, back up and protect from prying eyes these days is growing like federal deficits in the midst of a recession. Data storage needs are currently expanding by some 60% annually (although decreasing prices and increasing efficiencies mean costs rise at a fraction of that rate). That provides significant opportunity for companies such as Datalink Corp. (Nasdaq:DTLK), a tightly-run small cap that designs, installs and services customized storage systems that keep corporations running.

Datalink, based in Chanhassen, Minn., is one of the few IT companies enjoying a strong run in a weak market. It beat Wall Street estimates in the last two quarters, and guidance for the coming quarter is strong. In the first quarter this year, reported on April 16, revenue was up 17% to $47.7 million, a record increase for a first quarter, which tends to be a weak one. Net income was $769,000, compared with a $153,000 loss a year ago, and at $0.06 per share beat Street estimates by a penny. Its gross margin of 26.5% was the highest since the fourth quarter of 2004, its backlog of $30 million was only slightly off the previous quarter's record $31 million, and the company's second-quarter guidance is for EPS between $0.07 and $0.11 on revenue of $48 million to $52 million — and this is a company that tends to hit the high end of its guidance. Datalink's current growth rate is about twice that of the overall industry rate of about 6%.

But Datalink doesn't seem to be getting much love from investors. At Tuesday’s closing, the stock was at $4.85, well below its 52-week high of $7.17, reached last June as it was suffering through its second consecutive quarter of losses. The stock has barely rebounded from its 52-week low of $3.54 just before earnings were announced. Its market cap is $61 million.

In his April 17 report, analyst Clinton Morrison with Feltl & Co. wrote: "We have a hard time understanding why DTLK should be trading close to the bottom of a two-year range." Morrison rates DTLK a "strong buy" with a target price of $7, based on a multiple of 14 times earnings plus cash for 2008 — and he's keeping his growth estimate for the year at just 12% as a hedge against the current uncertain environment.

The only other analyst covering the company, Glenn Hanus at Needham & Co., also has a "buy" recommendation and a $7 price target, based on a multiple of 12 times his estimated 2009 operating earnings of $0.42.

So why the Rodney Dangerfield treatment? There are several reasons. The economy is one, especially since this tends to be a lumpy business. It's hard to tell when customers might suddenly pull back. "Visibility never goes out much further than the next quarter," says Feltl's Morrison.

It's also a competitive business, and the only advantage Datalink can claim is the expertise and experience of its team in creating and maintaining storage systems. The company is a value-added reseller, using hardware and software from other manufacturers, such as Hitachi Data Systems, Sun Microsystems (Nasdaq:JAVA), NetApp Inc. (Nasdaq:NTAP) and Data Domain Inc. (Nasdaq:DDUP). Theoretically, anybody can set up shop and do this. "Systems resellers never get a whole lot of respect," says Morrison, although he notes that Datalink has a "deep bench of talent" and a higher percentage of technical people than most competitors.

But one thing that really seems to rankle investors is regular stock sales by Datalink's chairman and former CEO, Greg Meland. Since retiring, he regularly sells shares each month in order to diversify his portfolio, and doesn't seem to care what the price is (when Datalink's price dropped last year, he simply lowered the minimum price at which he would sell). "I've heard from a number of retail and institutional buyers who are bugged by that," says Morrison.

Finally, increased efficiencies could hurt the data storage industry. The current trend in data storage is "virtualization," the ability to set up networks of disk drives in such a way that their capacity can be combined with others to form "virtual" storage devices. That allows companies to re-allocate idle capacity from one disk drive to any virtual storage well that needs it, rather than buying a whole new drive. Datalink is making a big push in this area, though after helping its customers increase efficiency, the company might just decide to hold off adding more real capacity in the current economy.

But given its current financial strength, there could also be some acquisitions coming. Datalink generated $1.4 million of positive operating cash in the first quarter, its eighth consecutive quarter of positive cash flow. It has $26.4 million in cash and no debt. It has successfully integrated the acquisition of Midrange Computer systems, which it bought for $14 million in cash and stock in February 2007, increasing its geographical reach and the number of engineers installing systems. Current CEO Charles Westling, a former investment banker, noted in his conference call with investors: "We continually have dialog with companies throughout the industry."

A little delayed love from investors might help that prospect. Or perhaps an acquisition, by growing its size and eliminating a few competitors, will inspire investors to give the company the respect it deserves.

About the Author
Richard L. Brandt is a journalist and author with more than 20 years' experience covering science, technology and business. Read More